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The current legislation provides for a “deemed tax credit” which fulfils the obligation for a basic rate tax payer and the first part of the liability for higher and additional rate tax payers. Non-tax payers currently suffer because they cannot reclaim the tax that is already deemed to have been paid.

The changes introduce a £5,000 dividend allowance within which all dividends received will be free from any tax liability. Dividend income in excess of this amount will be liable to tax at the tax payer’s marginal rate which for dividends from April 2016 will be 7.5% for basic rate tax payers, 32.5% for higher rate and 38.1% for additional rate tax payers.

Dividends received within an ISA or a Pension do not fall within the dividend allowance.

So what will this mean in reality for an investor looking to achieve the most tax efficient income from April 2016.

Case Study - Fred

Tax Year 2016/17

Personal allowance: £11,000

Basic rate threshold: £32,000

Fred is 65 and is a basic rate tax payer. His only income is his pension income of £36,000 gross each year. He has £200,000 to invest, and would like an annual income of £10,000 from his investment to supplement this.

Fred has heard about the new dividend allowance and is discussing his options with his Adviser. The Adviser is considering investing in equities via an Old Mutual Wealth Collective Investment Account or an Offshore Bond with Old Mutual International.

Equities with a dividend yield of 5% would achieve the natural income he requires. The table below identifies the tax position on receipt of the income:

Amount of income within each band

Total

Personal Allowance

Basic rate band

Higher rate band

Pension Income

£36,000

£11,000

£25,000

Dividend

£10,000

-

£7,000

£3,000

Tax liability within each band

Pension Income @20%

£25,000

£5,000

-

Dividend Allowance @ 0%

£5,000

£0

-

Dividend taxed at 7.5%

£2,000

£150.00

-

Dividend taxed at 32.5%

£3,000

-

£975.00

TOTAL TAX

£5,150.00

£975.00

If Fred invested into an offshore bond instead, his tax position would be different:

A withdrawal of £10,000 each year would be within the 5% tax deferred allowance. As such, no chargeable event and therefore no tax liability would arise as can be seen in the table below:

Amount of income within each band

Total

Personal Allowance

Basic rate band

Higher rate band

Pension Income

£36,000

£11,000

£25,000

Bond Withdrawal

(within 5% tax deferred allowance)

£10,000

n/a

n/a

n/a

Tax liability within each band

Pension Income @20%

£25,000

£5,000

-

Tax on bond withdrawal

£10,000

-

-

TOTAL TAX

£5,000

-

Comparison of Fred’s tax position on the £10,000 withdrawal taking into account his £36,000 pension income

Offshore Bond

CIA - equities

Investment

£200,000

£200,000

Rate of Return

5% growth

5% yield

Dividend Income

-

£10,000

5% tax deferred allowance

£10,000

-

Chargeable Event?

No

n/a

Dividend Allowance

n/a

(£5,000)

Tax liability on the £10,000 withdrawal

none

£1125.00

Fred’s Adviser could consider splitting the investment equally between collectives and an offshore bond. This would ensure the dividend income fell within the dividend allowance:

Tax position if Fred’s investment is split equally between a bond and collectives

Offshore Bond

CIA - equities

Investment

£100,000

£100,000

Rate of Return

5% growth

5% yield

Dividend Income

-

£5,000

5% tax deferred allowance

£5,000

-

Chargeable Event?

No

n/a

Dividend Allowance

n/a

(£5,000)

Tax liability on the £10,000 withdrawal

none

none

This table assumes Fred’s income is as identified in the case study.

Summary

The changes bring opportunities for Advisers to contact their customers and discuss their future income requirements, and again highlight the importance of independent financial advice.

The new dividend allowance is a welcome addition for investors but it is important to remember that this is not an additional allowance but falls within the existing tax thresholds and the tax liability on dividend income in excess of the allowance will depend on which tax band it falls within as identified in the case study.

This article is a reminder of the benefits of investing in offshore bonds. Not only will the investments grow in a tax-free environment when held within the offshore bond (although prior to investment, income received may be subject to a withholding tax), making withdrawals within the 5% tax deferred withdrawal facility will provide a steady income without incurring a chargeable event. However, it is important that a bond is structured correctly, ie as a redemption option or a life assurance contract with multiple lives assured, to ensure that it will not end on the death of the investor and can be encashed in the most tax efficient way.

For financial advisers only. Not to be relied on by consumers.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth or Old Mutual International's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. We cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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